I think all of you have seen such ads at least once. Start trading on Forex and make a living! You can live like a king doing a few trades a day and never see your naughty boss again! All that stuff. You just need $1000 to start! Or even $100. I love these banners by the way:
One of my favorite characters is a guy sitting on a beach in a suite with his laptop, apparently trading on Forex. I don’t know why this is so popular in these ads. Even under pretense that Forex “can make you free” you would never need a suite in a first place, right? Yeah, but in unsophisticated minds a suite is a symbol of success, therefore a guy on a beach should be wearing suite… Ridiculous.
Let’s examine from statistical point of view why you as a “junior trader” are very unlikely to succeed having income from Forex trading or any trading for that matter.
Let’s start with a few assumptions. First, you have $10K of your own capital. You have some trading strategy in your mind that allows you to make 30% return on your capital at risk with 90% probability of success. Yet your strategy has a risk associated with it: probability of you losing capital at risk is 10%. You never put at risk more than 10% of your capital, so even if you occasionally lose your capital at risk you’re not going to go out of this business immediately.
This represents quite a solid trading strategy, many strategies in this world are much less profitable (and riskier). In fact it is so insanely great, I would implement it immediately should I know it myself 🙂
So, let’s see how this works. You put 10 trades of $1K each and on average, 9 out of 10 of them end profitable, so you gained 30% * $1K * 9. This is $2700 of profit. But one of your trades go sour and you lose your capital at risk, in our calculation it is $1K.
At the end your gain is $1700 which is basically 17% return on your capital ($10K). If you do 10 such trades per month, you have 17% return on capital (ROC) PER MONTH. That is a fabulous trading! You can assume this as an absolutely best dream-come-true scenario for most “traders” who start trading.
What happens when you start spending these profits? Remember, you want this to be your income stream, right? Let’s assume you’re going to spend $1500 every month regardless what profit you make. Naive approach would suggest that on average you’re in a consistent $200 profit every month after all expenses were made. However, this is quite far from what actually could be going on.
Now we need to employ a Bernoulli trial formula from probability theory.
Let’s say p=0.9 is a probability of making $300 in one $1000 trade. Let’s say q=(1-p)=0.1 is a probability of losing $1000. Let’s assume that we make 100 trades. We’re going to spend $1500 every 10 trades we make.
|Probability||# profitable trades||# of losing trades||Profit||Spent||Capital gain|
This is basically it. You might think that you will be making profit consistently, but apparently there is an accumulated ~29% chance that you don’t make any money, but actually lose some of your capital. You can see that even in worst cases your strategy makes profits, but your monthly expenses make your overall profit and loss much worse just because you take out your capital and not accumulating your profits to offset occasional losses for such risk/reward profile like I have just described.
What does this study show? Regardless of what you trade, even if you have a great profitable strategy, and your broker is not cheating on you (a common case among Forex brokers), whether it is Forex or stocks or anything, you shouldn’t consider your trading as an income stream. It is either investment or speculation, but you should not take profit out and spend it. You should accumulate and/or reinvest.
The only scenario when you make a living trading consistently with your own money is basically when you have a huge capital, you trade big and your monthly expenses are consistently much much less than your profits. Otherwise it is highly likely that you will go bust quickly and not only will become unable to generate any profits, but also lose a significant portion of hard-earned initial capital.
Sadly enough, these ads appealing to poor schmuck with very little capital and of course almost all of them go to zero quickly. What makes matters even worse, those guys don’t have any fantastic trading strategies in their minds, tend to execute poorly, make stupid mistakes, overly leverage their trades and put too much capital at risk without knowing what they are doing.
So, please don’t get suckered into this “trading for income” scam.